The Timor Sea has never been famed for offering oil and gas operators smooth sailing over the years.

However East Timor’s manoeuvring over the treaty with Australia about royalties from
Woodside Petroleum
’s Sunrise gas venture have escalated sovereign risk in the waters off our northern coast to a worrying new level.

The espionage claims that East Timor hit Australia with in April, related to the negotiations on the treaty, have knocked the Sunrise venture for six. Any hopes the partners had of breaking the stalemate over how to develop the valuable resource have all but disappeared for the time being.

That is troublesome enough, but the issue is spilling over to the other ventures in the Joint Petroleum Development Area (JPDA) – the waters jointly run by East Timor and Australia – including ConocoPhillips’ Bayu-Undan gas venture and Eni’s $US1 billion Kitan oil project.

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Along with the tax dispute over Bayu-Undan that has been simmering away since last year and a lack of clarity in some legal and regulatory processes in East Timor, some operators are signalling their confidence in investing in the nation’s waters has been badly damaged.

Invoking arbitration

Various theories abound on what is behind East Timor’s decision in April to use years-old allegations of espionage to invoke arbitration over the Sunrise treaty, formally called Certain Maritime Arrangements in the Timor Sea (CMATS).

The allegations date back to when the treaty was being negotiated by Australian and East Timorese government officials in 2004.

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On the face of it, should the treaty be invalidated the split in revenues between Australia and East Timor would revert from the 50:50 enshrined in the accord to 82 per cent in favour of Australia, given most of the Sunrise resource lies in waters formally – if incorrectly in the eyes of the Timorese – assigned to Australia.

But the move is being widely perceived as an initial step in a bid by the Timorese to secure a bigger chunk of revenues from Sunrise.

That may involve simply a fatter share of the pie or a stake in the project for East Timor’s new national oil company Timor Gap. Or, the Timorese may want to hardwire into a new agreement a requirement that secures its long-held aim, that Sunrise be developed through an onshore plant on its soil, rather than through floating liquefied natural gas as favoured by Woodside and its Sunrise partners: Shell, ConocoPhillips and Osaka Gas.

As of mid-week, the Australian government was still considering its response to the notice of arbitration.

However, some move is imminent, given Australia has only about 10 days remaining of the 60 it had as of April 23 to appoint an arbitrator, or seek to take a different course of action.

Some Timor Sea operators are worried the dispute has put the wider Timor Sea treaty framing oil development in the region in doubt.

Timor’s natural resources minister
Alfredo Pires
says Timor does not want to cancel CMATS as it wants to avoid the risk of terminating the Timor Sea Treaty. Rather, it wants the accord “invalidated" and renegotiated, which Mr Pires says would provide certainty for foreign investors.

Some in industry are concerned

It’s no surprise that view is not shared in the industry where some fear they may be forced to consider write-downs of assets in the JPDA.

Others, however, seem unfazed.

Italy’s Eni, a partner in Bayu-Undan as well as in the Kitan oil project that started up in 2011, is still planning to drill five wells in the JPDA over the next 18 months, presumably involving many tens of millions of dollars.

Its confidence is backed by the importance that revenues from the oil and gas ventures in the JPDA have for the East Timorese economy, given the lack of exploration success so far in the three wells drilled so far by India’s Reliance Industries and Eni in its own exclusive waters.

But the Sunrise venture is shaken and is for now doing little more than continuing with its social investment program in East Timor.

Despite more than a decade with little progress on Sunrise, the venture is for the moment holding together, drawn by the potential of the liquids-rich resource of 5.13 trillion cubic feet of gas seen as ideal for floating LNG.

In the meantime, East Timor continues to act as if onshore development of Sunrise is a certainty. In a round of speaking events last week in Singapore and the Philippines, Prime Minister
Xanana Gusmao
regularly highlighted plans for LNG production as part of broader ambitions for industrial development on the south coast.

Both governments say the taxation dispute over Bayu-Undan is unrelated to the arbitration process. Conoco, as the venture operator, is contesting $US227 million in taxes, penalties and interest it believes have been erroneously levied and has warned the issue has harmed its view on the investment climate in East Timor.

The Australian government is meanwhile thought to be considering a notice to East Timor on a probable breach of the double taxation agreement for interests in the JPDA.

In any case the feeling among some is that all the strands are connected and part of a broader strategy by the Timorese around Sunrise.

But it looks to be a murky and drawn-out play. Investors looking for action in LNG to the north should look instead to Papua New Guinea, which has its own hurdles but has leapt ahead in terms of sovereign risk.